27 Jun Equity, the fundamental asset element of the company
Equity informs us of the company’s shareholders’ equity, i.e., the resources for the acquisition of assets that do not come from third-party financing. Together with assets and liabilities, equity forms part of the company’s balance sheet and provides us with a great deal of information that enables us to make important decisions regarding the company’s future (see Article 26 of the Entrepreneurs’ Accounting Act).
Elements of the annual accounts
Article 21 of the Entrepreneurs’ Accounting Act lists the sections into which the balance sheet comprising the annual accounts of the company is divided:
- Assets: assets, rights and other resources economically controlled by the entrepreneur resulting from past events from which it is probable that the entrepreneur will make profits, and which are to be classified separately and according to their allocation as fixed or non-current assets and as current or current assets.
- Liabilities: Present obligations of the entrepreneur arising from past events, the settlement of which is likely to result in a decrease in resources that can produce economic benefits, and which should be classified separately as non-current or current liabilities and as current liabilities.
- Equity: assets remaining after deducting all liabilities and including contributions made by owners or partners that are not considered liabilities, as well as accumulated results and other changes affecting it, and equity must be distinguished from the other items comprising it.
As indicated above, it is the part that remains of the value of the assets after subtracting the obligations that include the liabilities. In this equity element we find the following concepts and groups that are part of the general accounting plan:
It includes the funds that the partners contribute at the beginning or for capital increases that occur after the creation and, therefore, are the company’s genuine own funds.
These are part of the profits generated in several fiscal years that are not distributed among the partners but are “set aside” to increase shareholders’ equity.
Negative results of previous years
This account includes the negative results of previous years that usually remain in this account until they can be compensated with profits or other actions. It is important that this item is fully compensated before distributing dividends from positive results so as not to affect the shareholders’ equity which, let us remember, must always be positive and greater than half of the share capital.
Profit or loss for the year
This is the profit or loss for the current year, whether positive or negative, which has not yet been allocated.
Certain non-refundable grants, donations or bequests also form part of equity.
Meaning and analysis of equity
The very name of net equity or shareholders’ equity indicates that the items together form the economic resources of the company that are its own, not demandable, and that it does not owe to third parties outside the company. We must emphasize that they do not have a financial cost for the companies and that they must finance the non-current assets and part of the current assets of the company.
Hence the concept of capitalization of the company; in a healthy and normal company the net worth must be positive. It is important to know the situation of the net worth to know if the company is functioning correctly: if we have a net worth greater than zero, it is financed with its own money and has no debts or obligation to repay it to third parties. A company that increases its net worth year after year thanks to profits increases its value and has a favourable and future situation, with the capacity to face possible future negative results. Moreover, in the event of a year with a negative result, a comfortable net worth will allow us to maintain a stable equity situation.
Likewise, we can, in certain cases, have a negative result. If the company generates losses that it cannot compensate and accumulates instead of retained earnings, negative results or results pending application, these decreases can reach a figure that exceeds equity, a fact that could lead to decapitalization or technical bankruptcy.
This situation may affect the solvency of the entity in both the short and long term, since it means that its current and non-current liabilities exceed its assets, and its resources are not sufficient to meet its payment obligations and debts.